Early Monday, French President Nicolas Sarkozy and German Chancellor Angela Merkel met to hammer out the details of a new fiscal pact.

Among other things, the pact would change existing laws to make it easier for EU regulators to challenge budget policies of member nations.

The overarching idea is to begin building a fiscal union that will correct flaws within the EU, which has a common currency and shared monetary policy, but no mechanism to ensure that all members are financially sound.

"We are beginning to create the fiscal union," Merkel told lawmakers Friday. But she stressed that the European debt crisis will not be resolved overnight, saying the process "will take years."

In what is seen as a concession by Sarkozy, the pact includes automatic sanctions for member states that violate an existing rule to keep budget deficits under 3% of gross domestic product.

On Thursday and Friday, government leaders from all 27 EU nations will meet in Brussels for what is expected to be the final meeting of the European Council in a year that has seen more than its fair share of such summits.

Merkel and Sarkozy both said last week that a fiscal pact should be written into the EU treaty so that budget rules can be properly enforced through broader oversight and automatic penalties for nations that fail to comply.

"Europe needs to be rethought," Sarkozy said. "It must be redesigned."

In a sign of what's at stake for the United States, Treasury Secretary Tim Geithner will spend most of this week in Europe to meet with top officials, including Sarkozy and the newly appointed Italian Prime Minister Mario Monti.

Last Friday, Merkel again ruled out the creation of eurobonds, which could drive up borrowing costs for creditworthy nations such as Germany. The European Commission has proposed issuing so-called stability bonds as part of a plan to pool government debt across Europe.

Merkel also stressed that the ECB should remain independent, underscoring the deep opposition in Germany to the central bank risking inflation by printing money to prop up troubled governments.

Sarkozy also said the ECB should remain independent, but he sounded much less draconian than his German counterpart.

"Naturally, the European Central Bank has a role to play," said Sarkozy. He did not want to debate what that role would be, but Sarkozy did say the ECB would act to prevent a deeper economic downturn in Europe.

The ECB is widely expected to cut interest rates for a second time in as many months at its regularly scheduled policy meeting Thursday. But few analysts anticipate the central bank will announce plans to make large and unlimited purchases of government debt.

Mario Draghi, who took over as ECB president in October, said last week that "other elements might follow" if political leaders adopt a new "fiscal compact."

The remark raised speculation that the bank could drop its opposition to large scale interventions in exchange for a real commitment from governments to get tough on fiscal offenders.

"Our view is that whatever emerges out of the December 9 European Council will be presented as a success and will pave the way for greater ECB intervention most likely via aggressive secondary market purchases," Mujtaba Rahman, an analyst at political risk research firm Eurasia Group, wrote in a report.

Meanwhile, EU leaders have also been discussing ways for the International Monetary Fund to help support troubled euro area nations as plans to leverage an overstretched bailout fund have come up short.

Stock markets around the world rallied last week as investors welcomed signs that policy makers are prepared to take bolder steps to contain the crisis, including a coordinated effort announced Wednesday by central banks to pump more dollars into the global banking system.

But the rally lost momentum Friday as investors focused on the challenges facing EU leaders as they grope for a solution to the crisis.

"After being repeatedly disappointed with EU Summits and promises of comprehensive packages, investors are duly skeptical and wary," said Marc Chandler, head of currency strategy at Brown Brothers Harriman.

Late Sunday, Italy, which has sparked worry over its weighty debt and rising borrowing costs, unveiled a budget proposal that included €30 billion in new taxes and spending cuts over two years, including reductions to future pensions.

About €20 billion would come from cuts, including major changes to how Italian workers' pensions are calculated and a one-year increase in retirement ages, effective in January, Monti announced Sunday night.

In announcing the cuts, Monti -- who also serves as finance minister -- said he would take no salary for either position. The proposal still needs Parliamentary approval.

Meanwhile, Ireland's prime minister, Enda Kenny, is due to announce new budget-cuttting measures later Monday. In a televised appearance, Kenny said Ireland was spedning €16 billion more than it was taking in.